Australian Floods Cause Drought in the Coal Market

The most important metallurgical coal basin in the world is
underwater. Open pits have become lakes, stockpiles are soaked, and rail
lines are submerged and in places destroyed. Damage is estimated at $5
to $6 billion.

Australia accounts for almost two-thirds of global coking coal
production. Much of it comes from Queensland, where an area the size of
France and Germany combined is underwater. That includes the Bowen
Basin coal region, which produces almost a third of the world’s coking
coal. The Bowen Basin was hit with 350 mm of rain in December, against
an average of 102 mm.

Floods are now receding from the Bowen, giving some miners an
opportunity to ship from existing stockpiles. Other mines are still
inaccessible, and several rail lines are still submerged or damaged. And
since open pits are still flooded and will take weeks to drain,
shipping from stockpiles only postpones the inevitable: a reduction in
met coal supply. Analysts think a recovery to pre-flood coal production
levels will take at least three months.

At least six major global coal miners have declared force majeure,
which means they can miss contractual shipments because of
circumstances out of their control. The list includes Anglo American,
Aquila Resources, BHP Billiton, Macarthur Coal, Rio Tinto, Vale, and
Xstrata. Mines responsible for between 100 and 140 million tons of
annual coking coal production are now under force majeure, representing as much as 40% of global supply.

And it’s probably not over yet. Australia’s Bureau of Meteorology
predicts both eastern New South Wales and southeastern Queensland have a
60% to 70% chance of receiving higher-than-average rainfalls between
January and March 2011.

What does it mean for coal prices and coal equities?

First, coal is not traded daily, like copper or gold. Coking coal
prices are set in quarterly negotiations between steelmakers and coal
miners; contracts for the first quarter of 2011 were mostly settled
before the floods, at an average of $225 per ton (already the second
highest level ever). So prices have not changed yet, but there is lots
of talk about where they will go next. Analyst predictions for the
second quarter range from $250 to $350 per ton.

Coking coal producers not affected by the floods are already
reflecting the increase, and that will likely continue. Teck Resources,
for example, climbed from below $59 to almost $63 in the last days of
December, before slipping with the markets. Western Coal and Grande
Cache Coal also made gains. The longer-term impact will of course
depend on how long it takes for Australia’s mines to return to normal
operations, but in general the situation supports Casey’s bullish
stance on coking coal: there is not a lot of supply, and demand is
constant, if not rising, so prices can only trend up.

Casey’s support for coking coal has already generated big returns on
at least one recommendation. Some ten months ago, I was on Business
News Network (BNN) talking about met coal and recommended Cline Mining
at just over $1. Those who traded on that advice are now looking at a
300%+ gain, as Cline is currently trading at more than $4, in less than
four months. And Casey’s Energy Report recently added a new metallurgical near-term coal producer to its portfolio.

As for thermal coal, prices seem poised to edge up slightly because
of the floods but, unlike metallurgical coal, there is plenty of
thermal coal to go around. The situation has disrupted just 8% of global
thermal supply. So while the floods may be causing a pop in thermal
coal equities, the increase is unsustainable. There are thermal coal
deposits all over the world, and many countries produce enough to meet
most of their energy needs. China’s thermal coal stockpiles remain very
healthy, for example, and it is the second-largest importer of thermal
coal in the world. The top importer is Japan, but even it only imports
some 113 million tonnes annually and relies on coal for less than 30%
of its electricity needs.

As such, the pop in thermal coal equities is not going to last.
Hence, investors should use the lift as an opportunity to reduce their
positions.

The floods are also a reminder of the extremes of Australian weather –
a prolonged drought in Queensland ended just two weeks before the
torrential rains began. And while the rains pound Queensland and New
South Wales, which cover the eastern third of the country, searing
temperatures have residents of neighboring South Australia and Victoria
on alert for bushfires. That is simply a reminder that Australia’s
weather can often impact the country’s all-important met coal mines.

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